Home equity loan interest is deductible
-- to a point
It pays to read the small print -- especially when it reads:
"Consult your tax adviser."
Those words accompany
almost every home equity loan or line of credit solicitation for
good reason. Tax regulations allow many people to deduct all or
part of the interest they pay on these loans, but there are exceptions.
Because of these potential pitfalls, experts say people should educate
themselves before borrowing against their homes.
"If you have the option to take a home equity loan vs. going
out and borrowing money at a higher rate which is not deductible and buying
a car, then of course the home equity loan is going to be better," says Sandra
Raiter, a tax analyst with the tax preparation firm Jackson Hewitt Inc. in Virginia
At the same time, Raiter says, "People would
get home equity loans -- you see the ads with the football star
saying, 'Get a home equity loan and pay off your credit card bills'
... and then continue to charge on their credit cards.
"It's not something to be done lightly."
Making a move
Thanks to changes in the tax laws dating back to 1986, many people
can benefit by moving debt with non-deductible interest -- such
as auto and motorcycle loans and credit cards -- over to a tax-deductible
loan or line of credit secured by a home. The tax advantage has
the effect of lowering the already low equity loan rate even further,
making credit cards look like a pretty silly way to manage debt.
"For home equity, you can deduct the interest on a loan
up to $100,000 regardless of where you use the money," says Thomas Langdon,
a certified financial planner and tax professor at The American College in Bryn
Mawr, Pa. "Let's say your children are going to college and you need extra cash.
You can take a home equity loan of up to $100,000 and deduct the interest payments
on the Schedule
The limit applies regardless of whether a borrower
has one $100,000 equity loan against a primary residence, or a combination
of loans worth that much but secured against two different homes.
Tighter tax restrictions apply to borrowers who take out home equity
loans that, along with a first mortgage, raise the debt to a level
above the value of the property.
In such circumstances, borrowers can deduct
the interest on only part of home equity debt. The
Internal Revenue Service determines the eligible debt by subtracting
the amount borrowed to acquire the property -- the first mortgage
-- from the fair market value of the home.
A homeowner with a $100,000 property and an
$80,000 first mortgage, for example, might be able to get an equity
loan for $45,000 under a 125 percent loan-to-value program. But
the house is worth only $20,000 more than the original debt, so
only the interest on the first $20,000 of the home equity debt is
deductible, according to Ron Kotick, a tax specialist with tax preparer
H&R Block Premium in West Palm Beach, Fla.
Langdon notes that equity loans used for home improvement qualify
for different treatment, however. They resemble first mortgages
for tax purposes. And since people can deduct interest on $1 million
worth of first mortgage debt, they have greater leeway than those
who use their equity loans for things besides a new deck or garage.
"It's called 'acquisition indebtedness' -- a loan you get
to build your house, a loan to buy your house, or any loan you take out to substantially
improve your home," says Roxanna Pletchan, a certified financial planner with
Lassus Wherley & Associates in New Providence, N.J.
For instance, someone with a $400,000 first mortgage who
added a bedroom wing for $200,000 could deduct all the interest paid. A similar
borrower who used the $200,000 loan for college expenses, on the other hand,
only could deduct the interest paid on the first $100,000 of the balance.
|How to run an equity equation
|1. Locate your Schedule
A, an IRS form used to add up your eligible deductions, including mortgage
and home equity interest payments, medical expenses and charitable donations.
|2. Find the annual statements provided
by your mortgage and home equity lender. Determine how much interest you
can deduct and enter the result on the appropriate line, which can be found
under the "Interest You Paid" subsection of the form.
|3. Take the sum of all your itemized
deductions and compare it to the standard deduction allowed all taxpayers
for the current tax year. If the itemized number is greater, you should
qualify for additional tax relief.
-- Posted: April 7, 2003